Banks are hopeful that paying more interest to depositors on savings account will actually bring down their cost of funds.

Since returns on these deposits are not subject to tax deduction at source (TDS), high net worth individuals may choose these accounts over other short-term instruments such as mutual funds and term deposits, banks reason.

Although the interest on savings accounts remains unchanged at 3.5%, depositors will earn more interest income from these accounts from April 1. Until now, banks paid interest on minimum balance between the 10th and the last day of the month and the average payout worked out to 2.9%. By paying interest on daily balances, customers will get the actual return.

Depositors have more reason to park money in savings account deposits, said Canara Bank CMD AC Mahajan. His bank will see additional interest outgo of around Rs 400 crore each year because of the change in interest calculation.

So far, banks have been aggressively targeting low-cost deposits which comprise savings account and current account deposits since the interest outgo on such deposits is low. This will change from the next fiscal as banks will pay a little more interest on savings account. As a result, banks net interest income is expected to dip by 15-30 bps.

The absence of TDS will be a big draw for high net worth individuals, who have been parking short-term surpluses in mutual funds.

Interest income of over Rs 10,000 earned from bank fixed deposits per annum is taxed at the rate of 10%. But interest income over Rs 10,000 each year earned from savings account will not be taxed.

Banks credit the interest on saving account every six months and the interest payment vary from one bank to another. SBI credits it in the first week of July and January while Canara Bank credits it in the first week of August and February.

Several bankers said their IT system is geared to transit to the new system of interest payment on a daily basis. Some banks feel that the move will benefit them as well.

We may have to pay higher return on savings account deposits now. But it is still a cheaper way of raising money, said TY Prabhu, CMD of Oriental Bank of Commerce, which will see additional interest outgo of around Rs 80-100 crore each year.

Banks had even approached RBI sometime ago, seeking a reduction in interest paid on savings account. However, the central bank did not respond. The impact will be felt more by private banks which have a larger market share for salary account deposits.

New private banks have tied up with several corporates, wherein the corporates directly credit the salary in the bank account of employees. For HDFC Bank, the share of low-cost deposits is 49% of total deposits, even as a large portion is in current account. SBIs Casa is around 43% as on December 2009.